StudentShare solutions
Triangle menu

Derivatives as a way of mitigating financial risk - Literature review Example

Nobody downloaded yet

Extract of sample
Derivatives as a way of mitigating financial risk

Certain creditor protection rules are extended to these derivatives and this helps to increase their security and reduce financial risks. The other side is that with excessive credit protection norms, capital markets will under price the credit risks. This means that risks that should be valued at say 100 Pounds will be considered to be worth only 80 Pounds. This increases systemic risks and helps to propagate credit booms. The reason is that the lending firm considers a risk of 80 Pounds worthwhile while extending loans whereas if the assets had a risk of 100 Pounds, the lending firm would reduce the amount lent (Chance and Brooks, 2010). The paper will examine how derivatives based on standard assets and bonds can be used as a method of mitigating risk. 1.1. OTC and ETD and risk management Two main types of derivates are available and these are over the counter derivatives – OTC’ and ‘exchange traded derivative contracts’ - ETD. OTC instruments are privately traded between two parties and the exchange is not involved. Instruments traded included forward rate agreements, exotic options, swaps and other types. The main constituents and partners in the OTC markets are banks, financial institutions and hedge funds. The market is estimated to be worth 708 trillion USD and most of it occurs in private without any public listing and declaration. Out of this amount, 67% is for interest rate contracts, 9% are foreign exchange contacts while credit default risk make up 8% and ht rest is made up of equity contracts, commodity contracts and others. Since there is no external counterparty that acts as a central agency and mandates the exchange of contracts some, element of risks can exist. These risks can occur if either of the party cannot or will not honour its commitments to pay the contracted amount. This possibility is rare since banks and financial institutions are expected to be stable. Hence, derivatives are used to make the appropriate profits in ITC markets (BIS, 2011). In the case of exchange trade derivatives, these instruments traded through the derivatives exchange serve as an intermediary for the transactions. The exchange takes a certain percentage from both parties as the initial margin. The combined revenue of the world's derivatives exchanges was about 344 trillion USD. Examples of instruments that form ETD are futures contracts, interest rate and index products, convertible bonds, and warrants. These instruments can be traded only through special derivatives exchanges such as KOSPI Index Futures & Options, Eurex, Chicago Mercantile Exchange, New York Mercantile Exchange and others. These instruments have certain guaranteed prices on the maturity value and the guarantee is given by the derivatives exchange that has already taken a margin from both parties. This helps to manage risks. Due to low risks, returns obtained are also less and may range in the 3 to 6% range (Bartram, et all, 2011). The derivatives market and risks are different from the equity market where individuals can take up stock trading on their risk. The firm whose stocks are traded in the stock market will not give any assurance about the price stability or that a certain amount of dividend is payable. The stock market exchange also does not regulate the transactions between the parties. Therefore, if the price falls, the risk is borne by the party. In effect, derivatives markets transfer the risk from parties that aver risk ...Show more


Derivatives as a way of mitigating financial risk October 19, 2012 1. Introduction Derivative is a type of financial instrument and a contract drawn between two parties for certain assets that are subject to variables such as value of the assets, dates and notional amounts…
Author : daltonschumm
Derivatives as a way of mitigating financial risk essay example
Read Text Preview
Save Your Time for More Important Things
Let us write or edit the literature review on your topic
"Derivatives as a way of mitigating financial risk"
with a personal 20% discount.
Grab the best paper

Check these samples - they also fit your topic

Risk And Project Management
All activities contain an element of uncertainty, particularly projects which are time limited and undertaken to arrive at a single goal. Because of the high level of uncertainty, there is also perceived a high level of risk. There is therefore the imperative to try to understand and control this risk, through risk management techniques.
20 pages (5000 words) Literature review
Ethics in financial institutions
For instance, a financial institution is expected to provide customers with the necessary information. This enables such clients to make informed decisions. Customers trust the financial institutions, which are genuine and offer objective information. In addition to that, it is imperative for the financial institutions to protect the confidential information of the customer.
12 pages (3000 words) Literature review
Enterprise risk management
Risks are identified as any scenario that can cause detriment to achieving organisational goals dictated by strategic leadership that erode competitiveness or represent threat to financial stability. Many organisations have developed some form of risk management approach, however there is a modernised approach to achieving risk mitigation known as enterprise risk management (ERM).
12 pages (3000 words) Literature review
Risk management
The objectives of the research are to investigate the nature of oil spillage risks; identify and summarize the existing understanding about oil spillage risk management; discover good practices in managing oil spillage risks and to provide a new framework that summarizes the findings and can be used further for managing oil spillage risks.
26 pages (6500 words) Literature review
This literature review on the derivates will cover on various aspects relating to the financial instrument such as types of derivatives, types of derivative contracts, the use of derivatives, and even the contribution of the derivative market to the economic function within a country. The evolution of the market led to the development of various financial instruments.
7 pages (1750 words) Literature review
Financial Reporting and Analysis
52%. The ratio declines further in 2010 to 47.37%. This is not much of a concern for the company as the net profit margin on sales is quite high. The net profit margin is 19.35% in 2010. Although
6 pages (1500 words) Literature review
Risk Management
Risk management is done in order to avoid risks from arising and also to minimize their consequences. First of all, it is needed to correctly recognize all known risks because the risks cannot be mitigated unless it is identified. So, it is done thoroughly and accurately so that all the possible risks can be assessed within time.
13 pages (3250 words) Literature review
Research for the Financial Risk Management Problems of Small and Medium-sized Enterprise in China
rocess through which investors and fund managers identify potential risks of their businesses and act in such a way that their business interests are safeguarded. Allen goes ahead to assert that the decision on whether to accept or take mitigation steps towards the potential
16 pages (4000 words) Literature review
Financial Derivative
However, in reality it is observed that the movement in the bond market and that of the CDS are not equal. The inequality is caused due to a number of reasons such as the imperfect match between the two contacts (Cornett and Saunders, 2003). During the financial crisis, the
3 pages (750 words) Literature review
How different size of firms using financial hedging techniques such as Forwards, Futures, Options and Swaps to manage currency risk
The various financial hedging techniques are the forward rates, options, swaps and futures. The market that deals with the options and
10 pages (2500 words) Literature review
Hire a pro to write
a paper under your requirements!
Win a special DISCOUNT!
Put in your e-mail and click the button with your lucky finger
Your email
Comments (0)
Click to create a comment
Contact Us